LPC: Dictionary deluge in CLO risk-retention lawsuit

Kristen Haunss

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NEW YORK, July 6 (Reuters) - How many dictionaries does it take to win a lawsuit? Four, according to the Federal Reserve (Fed) and Securities and Exchange Commission (SEC), or five, according to the Loan Syndications and Trading Association (LSTA).

The debate is part of a lawsuit that is trying to exempt Collateralized Loan Obligation (CLO) funds from having to hold 5% of their deals under risk-retention rules that are part of the Dodd-Frank Act.

The LSTA sued the Fed and SEC in 2014 to try to remove the 5% holding requirement for CLOs, arguing that a transfer definition in the rule did not apply. The LSTA also took issue with the regulators’ definition of credit risk.

CLOs are the largest buyer of leveraged loans and the need to hold 5% of the funds could lead to fewer deals and ultimately cut funding to companies. Critics of the holding requirement are also concerned that smaller managers may not have the capital to buy the required retention. This could lead to consolidation and further concentrate loan ownership.

The risk-retention lawsuit largely centers on one word in the rule, “transfer,” and who is the transferee and who is the transferor. Both parties have turned to dueling dictionaries to support their arguments.

In a June 7 court filing, regulators said that CLO managers control the selection of the loans they purchase and transfer them into a special purpose entity when selected, and turned to Merriam-Webster’s Dictionary of Law, the Palgrave Macmillan Dictionary of Finance, Investment and Banking and others to support their definition of transfer.

Regulators included Merriam-Webster’s Dictionary of Law’s definition in a footnote: “The noun transfer, to which the verb refers, is defined as ‘1: a conveyance of a right, title, or interest in real or personal property from one person or entity to another 2: a passing of something from one to another.’”

The LSTA argues that CLO managers do not “transfer” assets. The trade group said in an April filing that risk retention does not apply because a CLO manager never owns or controls the loans that are sold to the funds, and instead acts on behalf of the CLO to facilitate its purchase of the loans.

If a company employee buys something from Amazon on behalf of its employer, Amazon is the seller or transferor, not the employee. The same principle applies to the CLO market, according to Elliot Ganz, general counsel at the LSTA. If a manager buys a loan from a bank on behalf of a CLO, the bank is the seller or transferor, not the manager, he said.

“Every financial transaction has a transferee and the transferor, and everyone concedes the CLO is the transferee,” Ganz said. “Since the manager is acting on behalf of the CLO, as its agent, it is acting as the transferee not transferor.”

The LSTA cited its five dictionaries in the April filing as Black’s Law Dictionary, Merriam-Webster’s Collegiate Dictionary, The New Oxford American Dictionary, The American Heritage Dictionary and Random House Webster’s College Dictionary.

A Federal Reserve spokesperson did not return a telephone call seeking comment. An SEC spokesperson declined to comment. (Reporting by Kristen Haunss; Editing by Tessa Walsh)